China’s exchange rate policy has come under renewed scrutiny as trade tensions with major economies intensify.
In an unusually detailed defence issued on Oct 8, the People’s Bank of China (PBOC) rejected claims that the yuan is undervalued, saying Beijing neither needs nor wants to weaken its currency to gain a trade advantage. The statement did not name any country, but its timing matters. China and the European Union have opened a new round of trade talks, with Brussels seeking to shrink a trade deficit that reached 360.6 billion euros last year. German Chancellor Friedrich Merz has said the yuan is undervalued by 25 to 30pc, and European Central Bank President Christine Lagarde called in June for a global discussion on the currency.
The International Monetary Fund’s latest external sector report names China and the US as the main drivers of widening excess current account balances. China operates a managed floating exchange rate system, in which supply and demand determine the yuan’s value, with a basket of currencies as a reference. Its central bank does not target a particular rate or try to steer the currency’s long-term direction. Routine foreign exchange intervention ended after 2017, though Beijing keeps the option of acting against sharp moves that threaten financial stability. The yuan’s record since the July 2005 reform points the same way. It has appreciated 23pc against the dollar. Estimates by the Bank for International Settlements put its nominal effective exchange rate up by more than 50pc and its real effective rate by 35pc.
Since 2010, the yuan has gone through three appreciation and as many depreciation cycles, trading between 6.04 and 7.35 to the dollar. It has gained about 9pc since the start of 2025, including roughly 4pc this year, despite a widening gap between US and Chinese bond yields.
China rejects claims of an undervalued yuan. A stronger yuan could make Chinese imports dearer and raise the rupee cost of servicing yuan debt
China’s export strength rests on its industrial base: decades of reform, a large domestic market, complete supply chains, skilled workers and heavy spending on research. There have been periods when the yuan rose and China still gained export share. Between 2005 and 2008, for instance, the currency gained 21pc against the dollar while China’s share of global exports rose by 2.4 percentage points. It happened later in 2010-14 and 2021. Exporters have also moved into higher-value goods. High-tech products now account for nearly 60pc of China’s total trade growth. About 30pc of China’s trade is settled in yuan, and firms hedge roughly 30pc of their currency exposure. Sustained manipulation would also be hard in today’s markets. Global foreign exchange turnover reached $9.6 trillion a day in April 2025, with the yuan accounting for more than $800bn.
A central bank would struggle to keep a currency artificially weak for long against flows of that size. The dispute also revives an old question: how far do trade surpluses depend on exchange rates? There is no linear relationship between the two, and earlier periods of yuan weakness did not speed up China’s gains in export share. The US, meanwhile, has run large deficits through long stretches of a strong dollar. Capital flows and market expectations now weigh more on exchange rates than trade transactions do.
The bank’s sharpest criticism is aimed at the IMF’s External Balance Assessment. The model is built to analyse external imbalances, not to establish an equilibrium exchange rate. Its estimates can vary widely, and it does not adequately capture structural change over its 40-year sample. Rebalancing should come from stronger domestic demand rather than a higher yuan. China’s current account surplus has fallen from a peak of 9.9pc of GDP in 2007. Consumption’s contribution to growth rose from 37pc in 2010 to 52pc in 2025.
Under its 15th Five-Year Plan, Beijing promises greater reliance on domestic demand and further opening of the economy. There is, therefore, a strong case against treating a cheap yuan as the only explanation for China’s export success. It does not settle whether the currency is correctly valued today, however. Past appreciation does not establish fair value, just as a surplus alone does not prove manipulation. China’s industrial competitiveness is real, but persistent global imbalances still need adjustment from surplus and deficit economies alike.
For Pakistan, the yuan debate is about more than exchange rate policy. It tests how carefully Islamabad manages its growing financial dependence on China. Pakistan has fully drawn its 30bn yuan swap line with the PBOC and plans to ask for a larger facility when the current one expires in 2027. Its first Panda bond in May, 1.75bn yuan for three years at a 2.5pc coupon, and expanding trade with China have added to the yuan’s weight in its external financing.
For Pakistan, the yuan debate is about more than exchange rate policy. It tests how carefully Islamabad manages its growing financial dependence on China. Pakistan has fully drawn its 30bn yuan swap line with the PBOC and plans to ask for a larger facility when the current one expires in 2027. Its first Panda bond in May, 1.75bn yuan for three years at a 2.5pc coupon, and expanding trade with China have added to the yuan’s weight in its external financing. A stronger yuan could make Chinese imports dearer and raise the rupee cost of servicing yuan debt. A weaker yuan might bring some relief, but Pakistan cannot build its financial planning on a currency it neither controls nor can reliably predict. The risk will grow as yuan borrowing takes a bigger share of its financing.
Islamabad must, therefore, look beyond the immediate availability of Chinese funds. It needs to assess currency risk before taking on new obligations, broaden its export base and narrow the persistent gap between imports and exports. Chinese financing can ease immediate funding pressures, but it cannot replace stronger domestic production and durable foreign exchange earnings. Pakistan should welcome access to yuan financing. But a sound financial relationship is measured not by how much a country can borrow but by whether it can repay when exchange rates turn against it.
Published in Dawn, The Business and Finance Weekly, October 19th, 2026
